Major sukuk push on way

Dubai, January 11, 2011

Investor worries over the impact of defaults in Islamic bonds is driving a push for a better structure for asset-backed instruments that should help alleviate concerns, bankers and lawyers said.

Islamic finance industry body IIFM is looking to develop a template in 12 to 18 months that will help reduce some of the legal and operational complexities surrounding asset-backed Islamic bonds, or sukuk, its chief executive Ijlal Alvi was quoted as saying in a report in our sister newspaper Gulf Daily News.

The Nakheel property arm of Dubai's state-owned conglomerate Dubai World staved off default on a $4.1 billion Islamic bond after a last-minute bailout from Abu Dhabi in 2009, after Dubai World announced plans for repayment on $26bn in debt, spooking global markets.

Also still ongoing is Kuwait Investment Dar's discussions with creditors over a $100 million sukuk it defaulted on in 2009.

Asset-backed sukuk are seen closer to the spirit of Islamic law as they involve a transfer of tangible assets and investors become the legal owners of these in the case of default.

Investors were taken aback as they realised the majority of sukuk were asset-based and that these could not be accessed directly by sukuk holders following a default.

'People didn't really talk about asset-backed sukuk until the stress tests were applied,' said Tim Ross, partner at Latham & Watkins in Dubai. 'Some investors were caught off guard - they had an unsecured payment claim.'

As investors cried foul, market watchers hoped the industry would shift towards a securitised model, but that has yet to happen, as more than 90 per cent of transactions are still structured as asset-based sukuk.

'While asset-backed transactions, both conventional and Islamic, have been done in the Gulf, they are more difficult and costly for companies to undertake,' said Gregory Man, senior associate at Clifford Chance in Dubai.

He added that such transactions also face tougher legal and analytical requirements imposed by rating agencies and many companies in the region lack sufficiently robust internal systems to service and report on the assets to investors and agencies.

A master agreement would aim to provide a standardised base from which issuers could structure the sukuk in line with their own jurisdictions and increase awareness about the product.